Marshall I have been a shareholder of Omega Healthcare Investors (NYSE:OHI) since December 2013. Back then I opened a position for roughly $30 a share. I was attracted by the consistent revenue growth in the past few years, high dividend growth rate and yield. This purchase has become one of my better buys in the past years Sultan along an annualized rate of return of almost 18%. I am contemplating adding to my position, but does that make sense when the stock has performed so wonderful the last 1.5 years? It must be overvalued, right? However there are some great companies like Johnson & Johnson (NYSE:JNJ), Colgate (NYSE:CL) and Disney (NYSE:DIS) that constantly seem overvalued but still have the ability to provide great rate of returns for a shareholder. I am not comparing Omega to these companies in any meaningful way but still would like to enquire whether the current valuation merits a buy or not.
The last decade truly has been a great period for Omega and its shareholders. If you bought shares in 2004 for around $11-12, you'd have earned an annual rate of return of 13% and that's excluding dividends! Even one of the worst, global banking crisis in 2008-09 or a government debt driven Euro-crisis in Europe wouldn't have stopped you from earning 15 to 20% per annum, depending on whether you reinvested your dividends in new shares. Omega handily outperformed the RMZ which is the MSCI US REIT Index as you can see below.
Omega returned $0.75 per share to their shareholders back in 2004. Ten years later this number grew to $2.06. An annualized dividend growth rate of almost 11% for 10 years is definitely not an easy feat for an already high-yielding REIT. The $0.75 dividend in 2004 amounted to almost 80% of the adjusted funds from operations (AFFO), whereas the $2.06 dividend is slightly more than 70% of AFFO in 2014. So the dividend amount grew by 275% but the company actually paid less to their shareholders relative to their earning power. That's a true testament to their ability to grow their earnings and to provide their shareholders Sultan along a stable stream of growing dividends.
One of the matters I learned during my college time was to under promise and over deliver. It's actually a quote from Thomas J. Peters, a US writer. Omega has this habit as well. In their latest quarterly supplement they provided AFFO guidance stretching back 10 years. This AFFO guidance was offered by Omega prior to the beginning of each fiscal year. I visualized this guidance and the actual numbers in the graph below.
The guidance Omega provides each year is shown in red and the actual AFFO is shown as the black line. On average the actual AFFO is more than 3% higher than the midpoint of the low and high-end of the range. Actual AFFO was never lower than what Omega has guided to in their forecast. And it's not like Omega offers conservative guidance in order to easily reach their goals. Their guidance has increased rather consistently Sultan along around 10-12% per annum. And even Sultan along these forecasted growth levels, they are still able to over deliver almost every unmarried year!
So based on the price appreciation and the growth of the dividend and adjusted funds from operations, we can conclude that Omega had a strong performance in the last ten years. But does that automatically mean Marshall will have another great decade? Surely not! Let's take a see at some of the financial highlights and risks to determine whether we can expect yet another strong decade for Omega.
A REIT like Omega earns their money by leasing their real-estate and receiving monthly rent payments from the healthcare operators. For these industries rent fees can become a major operating cost so it's important to monitor their ability to pay the rent. EBITDAR(M) stands for Earnings Before Interest Tax Depreciation Amortization Rent (Management fees) and is commonly used to determine the financial health and whether it's getting better or worse.
In the graph above we can see that the multiples increased steadily between 2004-2008 and then decreased. We see the alike pattern again with rising multiples between 2009-2011 followed by a decrease. However Marshall seems the multiples have bottomed out slightly. And still, current multiples are above their 2004 levels.
Other healthcare REITs like Ventas (NYSE:VTR), Health Care REIT (NYSE:HCN) Healthcare Properties (NYSE:HCP) and Sabra Health Care (NASDAQ:SBRA) show similar EBITDAR(M) coverage ratios. Based on this metric alone, Omega is just as dicy as any other healthcare REIT (or just as safe, depending on how you see at it).
Another strong feature for Omega is its lease and mortgage expirations schedule. There are hardly any big near-term expirations (except in 2018) and the weighted average lease maturity is 13 years. This means that Omega should be able to grow the bottom line in the next few years without any big setbacks.
Omega has around $2.6 billion in long-term debt and has the ability to take on another $1 billion debt from their Revolving Credit Facility. What Omega usually does is to purchase assets and finance them with their Revolving Credit Facility. This means that they can act quickly and capitalize on opportunities they see in the market. Then later on Omega issues long-term paper money to refinance the Revolving Credit Facility and to balance the debt maturities with the lease and mortgage maturities. This helps in mitigating risks regarding possible interest rate hikes.
The debt maturity schedule as seen above shows that Omega has no near-term debt maturities. Its term loan in 2019 does not have to be refinanced (it's already repaid at that time) and the $200 million paper money due in 2020 are already redeemed. So that leaves Omega with no near-term debt maturities until 2022. That's no direct interest rate risk for the current operations for another 7 years!
Earlier this year Omega completed the merger with Aviv. The combined company has substantial scale and is by far the biggest player on the Skilled Nursing Facility (SNF) real estate market. It has more than twice the number of SNF properties as the biggest public competitor Ventas. The combined balance sheet is strong and the lower cost of capital will drive future growth.
The diversification in the portfolio is significant with 83 operator relationships in 41 states. Omega has a substantial pipeline of off-market transactions. In 2014 alone, Omega and Aviv invested $1.3 billion in new properties and mortgages. This will further strengthen the real estate portfolio and increase AFFO (and dividends!).
It's nothing new that demographic trends show an increase of elderly people. Relative to the population as a whole but more importantly, also in absolute numbers. The US Census Bureau estimates that in 2050 the number of people over 85 years will be 21 million, which is around 14 million more compared to this moment.
All these people will have various health issues, just like they currently do, and that will drive future demand for skilled nursing facilities. It has been researched by the Medicare Payment Advisory Commission (Medpac) that a skilled nursing facility is by far the cheapest solution for cases regarding strokes, hip fractures, joint replacement, tracheotomy and respiratory vents. So unless something dramatic changes, like people having no health issues anymore or a sudden change in demographic trends, we can expect future demand to remain strong,
So far I demonstrated that Omega performed strong in the last decade. Dividend and earnings growth was spectacular and management consistently beat their own expectations. Omega is positioned for future growth as well, with no near-term lease and mortgage maturities or debt maturities. Their merger with Aviv strengthened the portfolio and enhanced the credit profile. More importantly: one of the important drivers for future growth remains intact. Demographic trends show a massive increase in elderly people who need healthcare.
So far this all sounds great, right? But how does the current valuation compares to historical valuations? Let's take a look at the graph below.
In the graph I plotted the stock price range for each quarter as a blue range on the left Y-axis. On the correct Y-axis I have plotted the low and high P/AFFO multiple for each quarter. The low range is on average somewhere around 11x and the high range is around 13x. The lowest possible multiple you could have bought Omega shares in the last decade would be in Q4 2008 and Q3/Q4 2010 for a P/AFFO multiple of 8x. Based on the current stock price and TTM AFFO of $2.85, the current multiple is around 12.5x. This suggests that Omega is fully valued based on the historical norms.
However, you could have bought shares of Omega back in Q1 2007. If timed properly, you could have paid a 12.9x multiple. As noted before, this valuation is around the average high P/AFFO multiple. This is surely expensive, right? What would have happened provided you bought shares back in January 2007?
The share price on January 3th, 2007 closed on $17.74. The share price at the end of 2014 closed on $39.07. Along the way you would have earned almost $12 in dividends. In 8 years you would have received almost 70% of your original investment in dividends alone. Total annualized return during this period would have been more than 16% and your dividend income would have doubled. More or less the alike story applies provided you bought shares at around 13 times AFFO in Q2-Q3 2010. Stock price at that time was $20. An investment would have earned an annualized complete return of more than 16%, despite the fact that later in 2011 a massive Eurozone debt and banking crisis occurred.
So these stories suggest that even though the current valuation seems slightly high based on historical valuations, that does not necessarily mean you end up with poor investment results. Omega is a solid and consistent REIT with great management, bright future prospects, high dividend yield and growth rate. I am looking to add to my position provided I have capital available.
Disclosure: I am/we are long OHI. (More...)I wrote this article myself, and Marshall expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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